The monthly payments of 1.8 million mortgages could go from 313 euros on average to 918, if rates rise to 5.1%
Britain’s energy price crisis has eased after the government decided to cap consumer bills. But the budget plans of the new Prime Minister, Liz Truss, and her Chancellor of the Exchequer, Kwasi Kwarteng, could do a world of harm to mortgage borrowers. Banks are unlikely to come out unscathed.
Friday’s Kwarteng mini-budget forced investors to reassess their expectations about how quickly the Bank of England will raise rates. This is because the collapse of the pound sterling and the tax cut of 45,000 million pounds (50,000 million euros) can fuel inflation. Market prices imply that the Bank of England base rate will hit 5.1% in February, versus last Thursday’s expectation of 4.1%. Rising borrowing costs are already forcing banks to withdraw old offers.
The timing couldn’t be worse for borrowers on cheap fixed-rate mortgages who must either refinance next year, or switch to an expensive variable load that contains short-term rates. According to the employers’ association UK Finance, there are 1.8 million loans of this type that mature in 2023. The average number of outstanding fixed mortgages has a rate of 2.07% and a balance of 164,000 pounds (184,000 euros), which means that interest represents 280 pounds (313 euros) of the monthly bill.
The same borrower could have to pay 6% or more next year, since mortgage rates are usually a percentage point above the base rate. That implies 820 pounds (918 euros) of monthly interest. The increase of 540 pounds (604 euros) is equivalent to a quarter of the average monthly salary after taxes, according to data from the Office for National Statistics.
Rising interest rates will reduce spending and hurt the housing market, further undermining Truss and Kwarteng’s growth plans. The effect will be exacerbated by the growth in mortgage lending during the housing boom decades. Capital Economics believes that, at the levels forecast Monday, mortgage costs could reach their highest level relative to borrowers’ income since 1990. House prices fell 20% between 1989 and 1992.
The contraction is unlikely to turn into a banking crisis. Lenders such as Lloyds Banking Group and NatWest have larger reserves on their balance sheets than in the past, and have lent more prudently. The proportion of new mortgages with a loan-to-value ratio greater than 90% has hovered between 1% and 5% in recent years, up from 15% or 16% in 2007. Instead of having to bail them out, regulators and politicians can pressure lenders to offer holidays or cut interest rates.
The British Government has chosen to absorb the costs of rising energy prices. You will find it equally difficult to let mortgage borrowers suffer alone.